Part one: Non-bank Financial Institutions
Introduction of non-bank financial institutions
According to Ibrahim (2018), Non-bank financial institution is an intermediaries where provide its customer financial services without holding bank license. But the finance activity such as insurance, factoring, lending and etc. is entitled by BNM (Bank Negara Malaysia). Other than that, the license required is issued by minister of the finance in Malaysia on the recommendation by Bank Negara Malaysia.
According to Rediff (2007), Bank is defined under BAFIA 1989 (replaced to FSA 2013) where NBFI is required to register their company under Company Act 1967 to provide financial service other than banking service such as saving account and current account. Money-Zine (2018) has summarize the service that provided by NBFI, which is risk pooling (organize the fund and spread the risk among all members), institutional investors (mutual fund that trade securities exchange for a low commission such as pension fund.), and other non-bank finance service such as leasing, financial advisor, security broker and etc.
Other than that, NBFI is not allow to receive demand deposit (which is the short term deposit from depositor). In a simple words, NBFI is not allow to provide saving or current account to their customers, not providing any settlement of payment service or providing cheque service (Rediff, 2007).
Example of Non-Bank Financial Institutions.
The non-bank financial institution that has been offered are pawnshops, credit union, pension funds, insurance companies, finance companies and so on.
First, pawnshop is a lending institution that referring when borrow loan need to pledge a personal property as a security of the loans. Pawnshops can be considered as a private enterprise usurious loan. The operation of pawnshops and capital formation are supervised by the country’s law, state law as well as private law. The pawnshop specializes in providing consumer credit secured by chattel mortgages, which the pawnshops will storing and selling mortgaged assets based on customer value. Pawnshops business sometimes will happen some cases like when the brokers of the pawnshops lack of credit agreements and encumbrances with customers. When approving the mortgage loan, the borrower will gets a ticket. The borrower registers a registration number in the log file. The registration number specifies the details of the borrower and the basic terms of the transaction. Pawnshop will provide a long period of time to allow its customer buy back their property. Only if after the allowable time, pawnshop only can sell the property legally to earn profit. (DIMA 2013). For example, Pajak Gadai E Assets Sdn. Bhd is one of the pawnshop in Malaysia.
Credit Union is an organization that pool the fund from its member and provide an interest benefit to its participants. That its member can borrow money from the pool of fund in a lower interest rate compare to bank (around 1% interest rate per month). And the profit earning will as a reward share to all the participant in the credit union. Other than that, if the members of Credit Union are not satisfied about the performance of the board of director, those members is allow to vote for the new director who has above the majority age. There are no limit amount that the member should distribute, the member can just distribute RM5 per month depend on how the member expect about the Credit Union. The saving amount represent the credit score of the members and the maximum amount that the member allow to borrow. All the members only allow to borrow maximum of 50% of the saving. For example, if the member only distribute RM100, he/she is only allow to borrow maximum of RM50 (Aidan, 2009). For example, Koperasi Peserta-Peserta Felcra Malaysia Berhad(KPFMB) is one of the credit unions in Malaysia.
Insurance company is a financial institution that provide its customer a promise to compensate the customer’s loss in exchange for a fees (called premium). Insurance company is practicing a risk pooling that receive their customer fund (premium) to do investment, and in case one of the customer incurred an accident, the insurance company will compensate it by using the pooled fund. Due to some insurance policy provide a accumulate cash value, sometimes insurance policy can pledge as a security for borrowing a loan. (Farlex, 2012). For example, AIA Insurance Company in Malaysia.
A pension fund is an investment product. Planned members pay the contributions from their salary to the pension fund to establish a one-time retirement income. By contributing money to pension fund, it allow the contributor receive certain amount of tax deduction. In many cases, this plan is provided by the contributor’s employer. This money is invested in a set of funds similar to retail funds, specifically for retirement savers. These mergers in one portfolio can get a low but stable cash benefit in it (EMMA 2014). For example, Private Pension Administrator (PPA) Malaysia.
Beside the example above, NBFI also provided few services that able to help people or corporation to finance its cost and protect it. Such as leasing, gearing, factoring, insurance, broker services and also provided financial advisers (money-zine). These services help to solve different problem encounter by the firm and individual. For example, gearing allow individual to borrow money to make additional investment for a better live they desire, but it will be relative risky as the money is borrowed. Leasing allow the owner of the specific asset to transfer the possession to another party to use at a specific time for an agreed term of return, usually money. NBFI act as a middle man in the contract and it is important for both party as they have profession personal to monitor the process and make sure the legal of it (BD, 2018).
Importance of NBFI
First and foremost, it increase the employment rate. Non-bank financial institution (NBFI) able to generate more job opportunity in a country as it is a necessary service in our life. By encouraging SMEs and private industries through lending them loans. It stimulate the economic growth in the country. By demanding the loan from NBFI, the business would have more capital to run their project. In this circumstances, the manpower needed by business will increase therefore more people will be hired and lead to a lower unemployment in the economy Malaysia.
Furthermore, the non-banking financial institution play an important role in rising of standard living. As the demand for the service of non-banking financial institution increase, it will attract the fund come from public and fund collected are used as capital for them to stimulate the economic growth. For example, transfer of fund such as telegraphic transfer can be charged approximate of 10% for total money transmitted, the income growth rate of fund transfers are expected to increase approximately 15% increase per year (Cooper ; Lybrand). When the economy grow well, all people are employed and the unemployment will decrease. When the income of the people increase, purchasing power of the people will rises and standard of living increase because they are able to buy more luxury things (One source, 2017).
Next, non-bank financial institution provide long-term credit to finance the project which need a big capital injection such as Mega infrastructure project. Yet, the traditional bank institution is unusual to offer this facility since commercial bank usually hold depositor’s fund for only a short term period (depositor’s saving), it is too risky that the commercial bank lend to a business for a long tenure and big amount. Through equity participation, non-bank financial institution inject the fund to corporation. There are two type of fund which divided into open-ended and close-ended (investing answers). Open-ended fund or mutual fund is a fund invest in stock market and bonds, it purchase shares directly from the fund itself. While different from OEF, close-ended fund is issue by an investing company with a fixed number of shares in the IPO, in return of investing in securities such as stock, preferences share and also in ways of bond (Elvis,MAR 12 2014).
There is another issue that been bothering Malaysia for a long time, it maybe not stated and speak among Malaysian, it is the problem of loan shark. Loan shark is illegal in Malaysia, many people fall into the trap just because they cannot find the loan from conventional bank as they may not meet their requirement. Thus, they are out of option and turn into loan shark which have no requirement but relatively higher interest rate. Some Small Medium Enterprise may also run out of luck as their funding encounter problem and turn on borrowing from these illegal business unintentionally. They may be friendly but their demand repayment may be ridiculous as a case that MR Chan borrow for RM3000 and have pay on full, but they request RM1500 more and threatening him to chop off his hand if he won’t pay(Chong,2018). Loan shark have affect our economic directly and also indirectly, by going thru borrowing from them, the victim are unaware of its identity and thus fall into the trap.
To solve loan shark problem, credit union may able to lend money to the person but they will have to deposit a certain amount of money before they can borrow and you will become a member of the union (Money Advise service, 2018). The union might charge u up to 1 percent average each month as we paying the loan. So credit union provide lower interest rate compare to loan shark. Why do we go for higher instead we can get funding from a lower interest rate? Although the union maybe huge and going non-profit basis, people or company still can get financial advice and loan with a relative low interest.
Another issue that maybe solve by NFBI in term of financing daily operation and also protecting future living standard. Insurance have brought us many benefit therefor there are essential for our Malaysia financial landscape. By protecting the client of the bank, its basically secure the base of the bank and therefor allowing banks to further dealing with more opportunity by giving out loan(ADEVA,2018). The client of the bank will have to follow the terms & conditions of insurance policy to not let the policy lapse, thus, to obtain the loan. Insurance company will adapt their policy to safeguard the living standard of their customer by compensate any accident of unpleasant event occurs such as death of a family pillar or director of company. For example, Allianz has given out personal insurance and also business insurance. For individual insurance, we have house insurance such as smart home cover, for business, they provide asset insurance to protect the firm from unexpected event such as fire or burglary (Allianz, 2018).
Contribution of NBFI
In Malaysia, bond market have grown in size and depth over the years. This is due to reliance on dept securities by NBFI to fund all the credit activities. Almost 40% of credit intermediation activities are undertaken by Non-bank institution (BNM, 2011). Now NBFI have a size of total assets RM1500 millions contribute to our financial industry. Insurance, Takaful and DFIs have contribute26% ,unit trust have 18%, pension fund held 41% which is the most quote in the chart, and the left is separate to other small NBFI such as securitisation entities (BNM,2011).
Stated by BNM, the linkage of NBFI with banking system are usually take form of deposit placement to the bank for risk diversification. Thus, the research shows that deposit made by NBFI have approximate 10% of total deposit made from depositor with commercial banks as showed in the report in year end 2011(BNM). The placement of deposit by the NBFI are spread out to several banks to diversify the risk of funding concentration of a bank level (BNM). This increase the bank for their capital base and thus can give out more loan to increase their profits, result in enhancing their bank capability.
Part two: Development Financial Institutions (DFIs)
What is Development Financial Institutions (DFI)
First and foremost, Development Finance Institutions (DFI) are financial institutions that owned by more than one country (multilateral DFIs) or only one country (bilateral DFIs) in order to enhance the economic growth and provide an extra support to development of targeted sectors. DFI provide an extra financing facility to help private sectors in development. For example, DFIs sometimes do provide the financing service in order to increase the capacity of developer for land development. Foremost, they focus on support private sector especially in low and middle-income country to promote job opportunity (Daniel and Christopher, 2017). When the people are employed, the residents in the specific country will able to have more income to spend in consuming goods. This will lead to a rising in GDP and stimulate economic growth.
Nonetheless, larger private sector corporations that unable to gain sufficient financial resources from local banks or private banks can look for extra credit from DFIs (Jose, 2017). DFIs act as a financial agencies by giving medium and long term financial support to undertake the event of promoting and development of targeted industry (Economy 2013).
Role of DFIs
DFIs in Malaysia have to ensure their lending process or action will not lead to a direct or indirect loss to the government. In order to reduce DFIs’ chances of loss, DFIs is able to gain a lower interest rate loan, reserved government as a guarantee to the institution’s liability, special condition for their debt instruments and also advantageous in tax treatment when they running a project. DFIs is not only provide an extension credit to private sectors, they do run projects.
Furthermore, DFIs in Malaysia is require to follow the policy that set by government Malaysia, that is, supply extra financial services to the project that unlikely undertake by commercial bank. For example, long term financing project which consists higher risk. These projects needs DFI to carry out because it required more professional advising and knowledge. (BNM, 2012)
DFIs have modified and develop more commercial activities compare to their specified roles which established by them. They are going to engage in the development project which lightly being focused. Although engaging in these activities has commit some earnings potential to DFI, it has tighten the resources of these institution which can giving more pressure on their organizational capacity, technical expertise and also management capability to improve their sectors. A sufficient coordination of DFIs will result to a good policy formulation, strategic planning and also funding requirements.
DFIs in Malaysia
According to BNM 2018, there are six DFIs in Malaysia that defined under Development Financial Institution Act 2002 which are Bank Pembangunan Malaysia Berhad, Bank Perusahaan Kecil&Sederhana Malaysia Berhad (SMEs), Export-Import Bank of Malaysia Berhad, Bank Kerjasama Rakyat Malaysia Berhad, Bank Simpanan Nasional and also Bank Pertanian Malaysia Berhad.
Contribution of DFIs
In fact, at the year of 1999, DFIs Malaysia has conducted share of assets that worth 3.8% of the total assets of the banking sector. Other than that, DFIs as a financial institutions offered total loan that amounted to RM11billion which indicate 2.9% total loan of the banking sector. The distribution of the loans are located as 31% of the manufacturing sector, 17% to the construction sector, agriculture sector with 13.4%, transport and storage took 12.1 of it and last 10.3 to the real estate sector (BNM, 2012).
Vision and Objectives of DFIs
The Vision and objectives of DFIs is that they allocate financing facility to services sector, advanced agricultural sector, manufacturing sector, capital intensive and high-technology industries to support those sector in development and evolution (BNM, 2018). For example, DFIs embrace in new technology result in higher efficiency and effectiveness to provide the financial services. By using the technology intensively, it help in provision of communication network and infrastructure can be easier and can be more accessible.
Next, DFIs’ operation are supervised by a single regulatory agency to ensure the vision and objectives of DFIs is achieving effectively and efficiently. It is aimed to assure that their daily activities is carried out more carefully and the objective can be accomplished by according to their own functions and roles. In Malaysia, single regulatory agency is a governing and controlling structure with current enactment of main financial services legislation which have a stronger foundation. Together with adjustment to the Central Bank of Malaysia Act 2009, The Financial Services Act 2013 (FSA) and the Islamic Financial Services Act 2013 (IFSA) offer a stronger base to ensure that the framework of regulatory and supervisory are effective (BNM, 2012).
Next, DFI include bilateral development bank and multilateral development bank. Multilateral development bank is the supporting arms of private sectors who provide an extension credit to it. It is made up by above one country. The operation is mainly based on international law. It usually own by national government yet sometime will include other international or private institutions. (Oecd,2018 )
The main purpose of Multilateral Development Banks (MDBs) is to reduce the poverty issue and minimize the economic inequality which is the unequal distribution of resources among the different group in society. Other than that, (MDBs) also giving out professional advices and also financial support in the area of economic and social development activities in developing countries (Congressional Research Service 2014). In 21st century, the head of six MDBs should mandate their roles when necessary in order to respond the challenges like inequality, climate change, pandemics, fragility and also conflicts (Washington 2017).
Financial institution that establish by one individual country that aim to give financing facility to development project in a developing country called bilateral development bank. It is an institution that owned by or managed by one individual Country. They also can allocate all the funds that decided through the bilateral government negotiation. So, they are permitted to enter in funds and specific conditions. Example of the financial institution include DC Group (British Development Finance Institution), COFIDES (Spanish Development Finance Institution), and DEG (German Development Finance Institution). It help to facilitate the public project because rapid financing has been offered a main delivery channel. Public project can be done on time because the expectable and flexible delivery.
It plays a vital role to maintain the financial stability and good governance of Development Financial Institution(East Asia ;pacific, 2018).If the financial system is not strong enough, it is quite risky to mobilize the fund to the strategic sector like agriculture ,small and medium enterprises (SMEs), infrastructure and so on . A good capital budget will lead to a well allocation of resources to all the private sectors, when the resources is distribute well to the sectors which needed then the economy will only remain healthy.
Important of DFIs
Since the DFIs are government owned, the DFIs should follow the policy that the government set to decide how much budget that they can lend to the strategy sectors. Refer to appendix (diagram 1.1), we can see that the first quarter of 2018 that the agriculture apply for loan with total amount for RM245.5millions from DFIs, but the loan approval is only RM55.6millions. Based on the statement above shows that there is a relationship between the loan approval and the expansion of agriculture industry (shows in appendix diagram 1.2), the more loan get approved by DFIs will lead to a greater expansion of agriculture sector and vice versa. This represent a role of DFIs in expanding the growth of a targeted sector that the government targeted.
Same as the other sectors, which the government will control their budget and invest their fund to the sector that will be healthy for the economy in Malaysia. DFIs will play an important role to act as intermediary between the government and the strategy sectors. DFIs provide an extension of credit to those sectors that unable to get sufficient loan from the private bank to expand their business or sustain in the economy (JOSÉ, 2017). In this case, DFI is actually provide a more stable working environment and working opportunities to the economy. It is because when the strategy sector keep expanding or able to sustain in the economy, the business need not to unemployed their workers or even hire more workers to operate their business. This represent that the DFIs is actually increase and stabilize the employment rate in Malaysia. A stable employment rate is an indicator of a healthy economy. Which the DFIs in Malaysia play an important role in assisting promote the stability of economy.
According to Wee Ka Siong, 2017, SMEs have contributed 37% of GDP and 65% of employment rate in the economy Malaysia which represent a significant role that the government is not afford to ignore to stabilize the economy. And the GDP contribution is still expected to grow at the future. In this case, if there is no existence of DFIs, the GDP contribution by SMEs will decrease significantly due to insufficient capital to expand their business. Where in this case, DFIs will provide a extension of credit to the strategy sectors that within the government’s control.
GDP shows a productivity of the country, a high GDP means that the economy of the specific country is growing and active and showing an expansion or recovery of the economy. If the SMEs contribute a big portion of GDP in Malaysia, then the role of DFIs will become very important in this situation. Same as explanation above, those strategy sector provide a high risk to a bank, but the GDP contribution by SMEs are unable to ignore it. So that the DFIs are actually helping the economy Malaysia to maintain a healthy GDP by extending the credit to those strategy sectors such as SMEs. According to BNM, 2018 DFIs it is required by law that the DFIs policy should consistent to the government initiatives, so that the DFIs will also tighten their budget for subsidies when the government Malaysia plan to implement the contractionary policy and vice versa.
According to the 3Eaccounting, 2018, SMEs is defined as the company that the shares capital has below RM2.5million, it include manufacturing, agriculture, fishing and etc. but the income they earn is still subject to tax in Malaysia. In simple words says, the more sales they earn will lead to a higher taxable income. In this case, the DFIs is actually a platform for government to invest in strategy sector in order to improve the economy or, gaining more tax income from the strategy sectors when they generate more sales.
If SMEs are able to generate more sales and profits, some of the company may able to achieved 2.5millions of share capital and therefore to be charged at different tax rates. According to 3Eaccounting, 2018, the tax charges to them ( Companies which have the shares capital above or equal to RM2.5millions for first RM500, 000 is charged by tax at 18% but if above that, it will be charged at 20-24%. If non-resident company even have to charged up to the full tax rate at 24% of the whole revenue of the company. Since DFIs are not only supporting SMEs but also large companies, the role of DFIs in this situation is unneglectable.
Referring to statement above we can say that if those strategy sectors are able to improve their performance in their market, the government can have more reserve in their system. Government can use these income to tackle the country’s debt or even use these income to run some mega project like MRT to improve the economy. These projects will generate return and the government can continue to use the return to invest in different project or provide more benefit to the residents or Malaysians. Back to the point that the role of DFIs in this case, the DFIs extend the loan to the strategy sectors and promote the expansion of those sectors, it helps the government to generate more fund to improve the economy or provide more benefit to the residents or Malaysians.
Besides that, based on the appendix diagram 2, it says that the SMEs mostly use their financing fund to purchase working capital or leasing some fixed assets like machine. According to Wee Ka Siong, 2017, SMEs contribute 18% of the export in Malaysia. In this case, if the DFIs extend the credit to the targeted sectors, the SMEs will be able to produce more goods if they have more funds to import their raw materials and export the finished goods to foreign country. The SMEs will earn more income when they start up a new production cycle to overseas. This represent that the DFIs is actually acting a role in promoting the export of the strategy sectors in the economy Malaysia. When a company export more goods to overseas, it will increase the GDP of Malaysia too.